Tokyo / Reuters
Driving interest rates below zero, the Bank of Japan (BOJ) has turned a comatose government bond market into an enormous free-for-all, complicating the central bankâ€™s own efforts to kick-start growth and end deflation.
The $9 trillion market for Japanese Government Bonds (JGBs) had been all but paralysed since the BOJ began a massive monetary easing three years ago that made the bank the dominant buyer.
But in the two months since the BOJ announced it was imposing a negative interest rate, JGBs have become a volatile commodity, with prices swinging wildly as below-zero yields confound investorsâ€™ attempts to find fair market value.
â€œThe JGB market is really in a bubble, when you think about it as an investment vehicle,â€ said Takuji Okubo, chief economist at Japan Macro Advisors in Tokyo.
â€œTheir prices have moved away from fundamentals, and people donâ€™t have a traditional way to measure their value,â€ stated Okubo.
As the BOJâ€™s dominance distorts bond market functions and dries up liquidity, the central bank could have a hard time tapering its buying binge when it eventually chooses to exit its â€œquantitative and qualitative easingâ€ programme.
The bank theoretically could just sit on its enormous holdings until the bonds mature, but policymakers are unlikely to want those assets to remain on the balance sheet for decades. On the other hand, it might be difficult to smoothly taper off its asset purchases, much less sell its holdings.
So far, the BOJâ€™s money printing has kept the cost for financing the governmentâ€™s massive public debt very low. A spike in that cost could stoke market fears Japan may be losing control of its finances, potentially triggering a damaging bond sell-off, some analysts say.
â€œIt would be quite tough for the BOJ to taper such an enormous balance sheet without disrupting markets,â€ said a person familiar with the BOJâ€™s thinking. In the meantime, buying bonds that yield less than nothing is creating losses for the exchange-listed BOJ – not an immediate worry for the government but a potential risk to confidence in the guardian of the yen.
â€œThe BOJ is sitting on a lot of risk, taking a huge position,â€ said one fund manager who declined to be named due to sensitivity of the matter. â€œHow long can they keep buying so many JGBs? Not forever, but a long time.â€
BOJ officials publicly say the slide in bond yields into negative territory showed the Jan 29 move to adopt negative rates was effective in pushing down borrowing costs, and that volatility will fall as market players get used to the concept of negative rates.
But some BOJ officials worry that bond yields have become more susceptible to abrupt swings as speculators and newcomers to the market hoard 10- and 20-year JGBs, without much consideration to the risks and term premium.
As a result, the BOJ â€” which the International Monetary Fund says is reaching the limits of the amount of debt it can swallow â€” could face difficulties if it wants to expand its asset purchases, as markets expect it will.
â€œIf investors are buying long-dated JGBs just because they yield something, they may be under-estimating the risks,â€ said another official.
familiar with the BOJâ€™s thinking.
â€œThe BOJ needs to conduct market operations so that markets donâ€™t become excessively volatile,â€ the official said.
With the market dominated by the BOJâ€™s massive buying and its policy decisions bent on surprising markets, many market players expect high volatility to persist, giving Japanese investors who still hold a large amount of JGBs a headache.